It is a dilemma not just for students heading off to university at the end of summer but for their parents and grandparents as well. Which is the better financial decision: to borrow the money to pay tuition fees and other costs using the new student loan arrangement, at the risk of being indebted for decades? Or to somehow raise the money elsewhere and pay upfront?

Thanks to the complex way in which the loans operate – the scheme is only a year old and its effects are still sinking in – there is no clear-cut answer.

Broadcaster and money guru Martin Lewis caused controversy last week when he wrote in The Daily Telegraphthat using the student loan would, for many, make sound financial sense. He urged families not to become worried by the idea of debt, saying it could “scare youngsters away from higher education”.

He argued that because of the way the repayments are structured (see below for the full explanation) many people will never have to repay the sums borrowed. He would prefer the whole arrangement not to be described as “debt” or “loans”, rather as “contributions”.

He said: “Those who don’t earn enough to repay aren’t welshing on their debts, the system is designed that they shouldn’t be contributing to the cost of their education. What we have, in money terms at least, is no-win, no-fee higher education.”

Several factors determine the overall cost to the students of the money they borrow at college. One is their starting wage upon graduation, and how quickly it rises thereafter. The next factor is inflation, as the rate of interest charged on the borrowing is calculated according to prevailing inflation – as measured by the RPI, currently 3.1pc – plus an additional margin of up to 3pc. After 30 years everyone’s remaining debt is written off, irrespective of how big it is.

How these variables interact is where the subtleties arise. Very low earners, who never exceed the threshold above which repayments are made (currently £21,000), pay nothing. They would clearly have lost out had they paid up front for their tuition and other costs. And at the other end of the scale, high-flying graduates who launch straight into well-paid law, accounting or banking jobs should also do relatively “well”. This is because although they will have to repay the sums they borrowed, their rapid rate of repayment will mean less interest accumulates on the debt.

The middle-to-higher earners in between are those who will be hardest-hit. Intergenerational Foundation (IF), an independent think tank, produced a major piece of work last month comparing the outcomes for a range of students whose postgraduate earnings followed different scenarios.

It said middle-income graduates will need to earn an annual salary of £51,000 a year, more than twice the national average wage, in order to be able to begin paying off any capital on a £40,000 student loan. Those earning less would simply pay interest, which would compound at a rate that took years to diminish.

It meant earners in certain bands would be faced with never paying off their loan during the 30-year repayment period and would instead face an ongoing 9pc “tax”.

The IF also identified a wild card risk. It said it was “seriously concerned” future Governments could decide to increase interest rates or lower the repayment threshold. There is a clause in the student loan agreement that allows it to make changes to the repayment conditions, the IF found. Angus Hanton, co-founder of IF, said: “Policymakers are creating an indentured class of future graduates with little protection against further interest rate rises or a lowering of the repayment threshold.”

The calculations shown below make it clear that students – and their wider families – need to consider how much their earnings are likely to be in future.

This is hugely difficult. Where the option for families is to find money elsewhere, possibly earmarked for other spending or investing, the decision becomes even more difficult. Financial adviser Philip Milton, managing director of Philip J Milton & Company, said: “Parents and grandparents who are considering helping children or grandchildren pay university fees upfront should consider whether they are making optimum use of their money.”

He sides with Martin Lewis in saying: “Psychologically people think it is nice not to have debt, but there could be other ways to put your money to better use.

“Stand back and look at the bigger picture and work out what will make more financial sense for your particular situation in the long-term. Don’t automatically assume the best thing to do is pay off the debt.”

He suggests that even if a student’s parents or grandparents do have access to capital they might have other – potentially quite pressing – needs to use it elsewhere, perhaps to build pension savings, pay toward future care costs or clear their own mortgages.

HOW THE STUDENT LOANS SCHEME WORKS

Since September 1, 2012, all students in England can apply for tuition loans, covering their course fees, and maintenance loans that help with living costs such as accommodation, bills and books.

Full-time students can borrow up to £9,000 a year for tuition fees and up to £7,675 a year for maintenance costs.

A student borrowing the full amount would owe a little more than £50,000.

The rate of repayment is linked to earnings. Graduates must start making payments only once their salary reaches the threshold of £21,000 a year (before tax or National Insurance). The monthly repayments are 9pc of income over £21,000, so the more you earn the more quickly you pay it back.

Interest on the borrowing is calculated separately. It starts accumulating while you are studying at a rate of RPI inflation plus 3pc. That changes once students graduate and begin earning a wage. At that point the interest rate is calculated according to income on a sliding scale where higher earners pay a higher rate.

Graduates earning £21,000 or less accumulate interest at the rate of RPI inflation only.

Or, if you earn between £21,000 and £41,000, you pay interest at RPI plus a margin based on a formula where 0.00015pc is added for every £1 earned. Sound complex? It is. Put another way, your rate goes up by 0.15pc per £1,000 of pre-tax salary.

If you earn more than £41,000 you pay RPI plus 3pc, which is the maximum rate.

The interest continues accumulating until the loan is paid back in full.

It is an employer’s job to take graduates’ monthly repayments from their salary.

If the debt is not repaid in full after 30 years the remainder is written off.

Borrowers can repay their loans at any time, free of penalty, if, for instance, they inherit money.

The more you earn, the more a loan will cost you

How might a student loan work out in practice? Start by assuming he or she borrows the maximum under today’s allowances, of £50,000. And then assume that when they graduate and start to work, inflation (as measured by RPI) is, as now, around 3pc. Further, let’s assume their wages rise for the duration of your working career at 2pc above inflation.

These assumptions are basic and in reality crude – but they give a picture.

Take the graduate whose salary starts at £21,000. They do relatively well because although they will make payments for 30 years, their payments will total just £19,700, or about 40pc of their original borrowing.

Higher earners pay back more. A starting salary of £25,500, again growing at the same rate, would result in £47,000 being eventually repaid – still less than the original sum borrowed.

An initial salary of £36,500 sees the repayments really leap. That is because higher rates of interest are applying to the debt, and compounding up over the years. So this graduate would more or less clear their debt by the end of the 30-year period, having paid £112,000 – over twice the borrowed sum.

According to Angus Hanton of think tank Intergenerational Foundation this is because the interest racks up for higher earners at such a rate there will be some years when, despite making the required repayments, their total balance grows. He said the arrangement then becomes more “akin to a tax”.